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Optimism has been breaking out all over financial markets this year. The US fiscal cliff is solved, albeit temporarily; Europe’s stock markets are up; borrowing costs for eurozone countries such as Italy are down; and investors are snapping up junk bonds as if the financial crisis never happened.
The worst may well be over. But in Europe, at least, there is still a widespread failure to recognise the need for further radical adjustment. Nothing epitomises this failure so well as Spain.
Mariano Rajoy, the country’s prime minister, told the Financial Times this week that the Spanish economy would start recovering this year and the tide had finally started to turn.
It is true that at a macroeconomic level, Spain has clocked up significant progress. Exports are rising, the current account is in surplus and labour market reform has been passed. Tellingly, Spain is the only large eurozone country where unit labour costs are lower than they were in 2009.
But Spanish companies are still massively in debt and not only the obvious culprits in property and construction that fuelled the pre-crisis boom. And while the total amount of corporate debt relative to the size of the economy has fallen, the stock of gross debt as a percentage of net operating profits is still extremely high and may even be rising. This is a much better measure of whether the corporate sector is coming out of the woods, because it is a proxy for companies’ ability to service their debts.
At its peak, corporate debt, excluding the banks, represented 17 times total net operating profits – that is, it would take 17 years for companies to repay their debt from their profits. To give some sense of how high this is, in crisis-hit Japan in the 1990s, gross corporate debt peaked at 10 times net operating profits.
The latest numbers from Spain suggest gross corporate debt has fallen to just more than 11 times net operating profits – still a painfully high number – partly due to some debt being paid off and partly due to an increase in profits, reflecting companies’ savage cost-cutting. It is not only job losses in the public sector that have fuelled Spain’s gruesome unemployment rate – the number of private employees has fallen by a fifth from its pre-crisis peak, from 13m to about 11m. The aggregate numbers suffer from many flaws. There is good reason to believe, as Jamie Dannhauser of Lombard Street Research points out, that the national accounts significantly overstate the recovery in corporate profits – as other data suggest a much weaker picture.
But most worryingly, the numbers suggest that indebtedness is particularly acute at companies in those sectors on which future growth depends – manufacturing and tradeable services. The average industrial company in Spain now has a larger debt burden than anywhere else in Europe.
Struggling out from under this weight is not impossible. But it clearly suggests, first, that any resumption of economic growth in Spain is likely to be tepid at best. And second, that it is still much too early to rule out Spain going cap in hand to the European authorities for more bailouts. Which would be a blow to optimists everywhere.
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